Apply double-entry and GST principles to record credit sales, bad debts written off, and the allowance for doubtful debts, and report accounts receivable at net realisable value

What this dot point is asking

QCAA wants you to manage credit customers (accounts receivable) for a sole-trader trading GST business. You must record credit sales with GST, write off bad debts that are confirmed uncollectable, create and adjust an allowance for doubtful debts so that receivables are not overstated, account for the recovery of a previously written-off debt, and report receivables at net realisable value in line with the accrual basis and prudence.

Credit sales and the receivable

When goods are sold on credit, the business recognises revenue immediately under the accrual basis, even though cash has not been received. A credit sale of $2,200 including GST is recorded:

• Debit Accounts Receivable $2,200
• Credit Sales $2,000
• Credit GST Clearing $200

Accounts Receivable is a current asset. The risk is that some of these customers will not pay, so two related concepts manage that risk: bad debts (confirmed losses) and doubtful debts (estimated future losses).

Bad debts

A bad debt is an amount the business has decided is genuinely uncollectable, for example after a customer becomes insolvent. Because the original sale included GST that the business already reported to the ATO, writing off the debt reverses that GST. To write off a $660 bad debt (including$60 GST):

• Debit Bad Debts $600
• Debit GST Clearing $60
• Credit Accounts Receivable $660

Bad Debts is an expense reported in the income statement. The GST adjustment recovers the GST the business effectively overpaid on a sale that produced no cash.

Doubtful debts and the allowance

Prudence (conservatism) says profit and assets should not be overstated. At the end of the period, some receivables that are still outstanding will probably never be collected, even though no specific debt has yet been confirmed bad. To recognise this, the business estimates doubtful debts and raises an Allowance for Doubtful Debts, a contra-asset that sits against Accounts Receivable.

The estimate is commonly a percentage of net credit sales or a percentage of closing receivables. Suppose receivables (after writing off known bad debts) are $40,000 and experience suggests 2.5$1,000.

If there is no existing allowance, create it:

• Debit Doubtful Debts $1,000
• Credit Allowance for Doubtful Debts $1,000

Doubtful Debts is an expense; the allowance reduces the carrying amount of receivables. There is no GST entry on the doubtful-debts estimate because no specific sale has yet been reversed; GST is only adjusted when an actual debt is written off.

Adjusting an existing allowance

In later periods the allowance already has a balance, so only the movement to reach the new required balance is recorded. If the allowance currently holds $700 and the required balance is$1,000, increase it by $300 (debit Doubtful Debts$300, credit Allowance $300). If the required balance were lower than the current balance, the allowance is reduced and the excess credited back, reducing the expense.

Recovery of a bad debt

If a customer pays after their debt was written off, the write-off is reversed and the cash recorded. To recover a $660 debt (including$60 GST):

• Debit Accounts Receivable $660, credit Bad Debts Recovered$600 and GST Clearing $60 (reinstating the debt and GST)
• Debit Cash at Bank $660, credit Accounts Receivable$660 (recording the receipt)

Bad Debts Recovered is revenue (or a reduction in the bad-debts expense).

Reporting at net realisable value

In the balance sheet, accounts receivable are shown at net realisable value: gross accounts receivable less the allowance for doubtful debts. Using the figures above, $40,000 less the$1,000 allowance reports receivables at $39,000. This is the amount the business realistically expects to collect, satisfying the prudence and going-concern requirements of relevant reporting.